TREASURY
INSPECTOR GENERAL FOR TAX ADMINISTRATION

Late Legislation Delayed the Filing of Tax Returns and Issuance
of Refunds for the 2013 Filing Season

September 30, 2013

Reference Number: 2013-40-124

This report has cleared the Treasury
Inspector General for Tax Administration disclosure review process and
information determined to be restricted from public release has been redacted
from this document.

LATE LEGISLATION DELAYED THE FILING
OF TAX RETURNS AND ISSUANCE OF REFUNDS FOR THE 2013 FILING SEASON

Highlights

Final
Report issued on September 30, 2013

Highlights of Reference Number: 2013-40-124 to the Internal
Revenue Service Commissioner forthe Wage and Investment Division.

IMPACT ON TAXPAYERS

The filing season, defined as the period from January 1
through mid-April, is critical for the IRS because it is during this time that
most individuals file their income tax returns and contact the IRS if they have
questions about specific tax laws or filing procedures. The late passage of
legislation increases the risk that the processing of tax returns and issuance of tax refunds will be
delayed.

WHY TIGTA DID THE AUDIT

Enactment
of the American Taxpayer Relief Act of 2012 on January 2, 2013, significantly
reduced the time the IRS had to implement the tax changes it contained. The
objective of this review was to evaluate whether the IRS timely and accurately
processed individual paper and electronically filed tax returns during the 2013
Filing Season.

WHAT TIGTA FOUND

As
of May 4, 2013, the IRS received more than 133.6 million tax returns and issued more than
99.5 million refunds totaling more than $264 billion. However, due to the late passage of the American
Taxpayer Relief Act of 2012 and errors in tax preparation software packages,
approximately 11.6 million taxpayers were unable to file their tax returns
until February or March 2013, depending on the types of forms included with
their tax returns.

The
IRS reported that it identified 579,183 tax returns with $3.6 billion
claimed in fraudulent refunds during tax return processing and prevented the
issuance of $3.47 billion (96.4 percent) of those refunds. The IRS continues
to expand its efforts to identify and prevent fraudulent tax returns from being
processed.

The IRS offered a number of different options for taxpayers
to seek information and assistance. The use of self‑assistance options
has grown significantly. These options provide taxpayers with access to the IRS
24 hours a day, seven days a week. In comparison, declining IRS resources have
reduced the number of taxpayers the IRS estimates it can assist at Taxpayer
Assistance Centers.

Finally, many tax return preparers still do not comply with
Earned Income Tax Credit due diligence reporting requirements, questionable
education credits and Qualified Plug-in Electric Drive Motor Vehicle Credits
continue to be issued, and Homebuyer Credit repayments and dispositions are
still being incorrectly processed.

WHAT TIGTA RECOMMENDED

TIGTA
made recommendations to the Commissioner, Wage and Investment Division, to
improve the identification of questionable claims for the education credits and
Qualified Plug-In Electric Drive Motor Vehicle Credit and to reduce errors
associated with the processing of Homebuyer Credit repayments and dispositions.
In addition, TIGTA recommended that the IRS initiate programs to recover the erroneous
and questionable credits TIGTA identified and to ensure that Earned Income Tax
Credit due diligence penalties are assessed when appropriate.

The
IRS agreed with seven of TIGTA’s recommendations and partially agreed with one
recommendation. The IRS plans to continue to evaluate its processes to
identify questionable education credit claims. It also plans to establish
processes to improve the identification of questionable Qualified Plug-In
Electric Drive Motor Vehicle Credit claims, reduce errors associated with the
processing of Homebuyer Credit repayments and dispositions, and assess Earned
Income Tax Credit due diligence penalties. In addition, the IRS plans to assess
the feasibility of recovering the erroneous and questionable credits TIGTA
identified.

September 30, 2013

MEMORANDUM FOR COMMISSIONER, WAGE AND
INVESTMENT DIVISION

FROM:Michael E.
McKenney /s/ Michael E. McKenney

ActingDeputy Inspector General for
Audit

SUBJECT:Final
Audit Report – Late Legislation Delayed the Filing of Tax Returns and
Issuance of Refunds for the 2013 Filing Season (Audit # 201340010)

This report presents the results of our review to determine whether
the Internal Revenue Service (IRS) timely and accurately processed individual
paper and electronically filed tax returns during the 2013 Filing Season. This
review is included in our Fiscal Year 2013 Annual Audit Plan and addresses the
major management challenge of Implementing the Affordable Care Act and Other
Tax Law Changes.

Management’s complete response to the draft report is
included in Appendix VI.

Copies of
this report are also being sent to the IRS managers affected by the report
recommendations. Please contact me if you have questions
or Russell P. Martin, Acting Assistant Inspector General for Audit (Returns
Processing and Account Services).

As of May 4, 2013, the IRS received more than 133.6 million
individual income tax returns.

The annual tax return filing season[1]
is a critical period for the Internal Revenue Service (IRS) because it is when
most individuals file their income tax returns and contact the IRS if they have
questions about specific tax laws or filing procedures. As of May 4, 2013, the
IRS received more than 133.6 million individual income tax returns. In
addition, the IRS provided customer service assistance via telephone, website,
social media, and face-to-face assistance to millions of taxpayers.

One of the challenges the IRS confronts each year in
processing tax returns is the implementation of new tax law changes. Before
the filing season begins, the IRS must identify new tax law and administrative
changes and revise the various tax forms, instructions, and publications. It
must also reprogram its computer systems to ensure that tax returns are
accurately processed. Problems with tax return processing could delay tax
refunds, affect the accuracy of tax accounts, and result in the generation of
incorrect notices.

Tax law changes affecting the 2013 Filing
Season

·American Taxpayer Relief Act of 2012[2]
– Enacted January 2, 2013, this act increased the Alternative Minimum Tax
exemption and allowed nonrefundable credits up to the full amount of the
Alternative Minimum Tax. It also permanently indexes[3]
the Alternative Minimum Tax exemption for inflation and extended many tax
credits and deductions that expired on December 31, 2011, including the:

·Budget Control Act of 2011[4]
– Enacted August 2, 2011, this act required Federal agencies to implement
mandatory budget cuts. The IRS was required to make significant cuts in all
major program areas, including customer service, for the remainder of Fiscal
Year 2013 to implement the budget cuts required by the sequester.[5]
The IRS postponed necessary employee furloughs until after the completion of
the filing season.

The IRS processed individual income tax returns at three Wage
and Investment Division Submission Processing sites during the 2013 Filing
Season: Fresno, California; Kansas City, Missouri; and
Austin, Texas. In addition, the 2013 Filing Season marks the first filing
season in which the IRS accepted and processed all electronically filed (e-filed)
individual tax returns using the Modernized e-File (MeF) system. The MeF
system is a modernized, Internet-based e‑file platform that provides real-time
processing of tax returns that improves error detection, standardizes business
rules, and expedites return receipt acknowledgments. The MeF system replaced
the IRS’s prior e‑filing system (referred to as the Legacy e-File
system).

The 2013 Filing Season results are being presented as of
several dates including April 30, 2013; May 2, 2013; and May 4, 2013, unless
otherwise specified. This review was performed at the Wage and Investment
Division Headquarters in Atlanta, Georgia; the Information Technology
organization Headquarters in Lanham, Maryland; the Submission Processing
Site in Kansas City, Missouri; and the Submission Processing function
offices in Cincinnati, Ohio, during the period January through July 2013. We
conducted this performance audit in accordance with generally accepted
government auditing standards. Those standards require that we plan and
perform the audit to obtain sufficient, appropriate evidence to provide a
reasonable basis for our findings and conclusions based on our audit
objective. We believe that the evidence obtained provides a reasonable basis
for our findings and conclusions based on our audit objective. Detailed
information on our audit objective, scope, and methodology is presented in
Appendix I. Major contributors to the report are listed in Appendix II.

As of May 4, 2013, the IRS received more than 133.6 million
tax returns and issued more than 99.5 million refunds totaling more than
$264 billion. The majority of these tax returns were timely processed,
and tax refunds were issued within 45 calendar days of the April 15, 2013,
tax return due date. Figure 1 presents comparative filing season statistics as
of May 4, 2013.

However, the late passage of the American Taxpayer Relief
Act of 2012 and errors in tax preparation software packages resulted in approximately
11.6 million taxpayers being unable to file their tax returns until February or
March 2013 depending on the types of forms included with their tax returns. On
March 4, 2013, the IRS began processing all individual tax returns.

On January 8, 2013, the IRS announced that it was delaying
the start of the filing season to make the changes necessary to implement
provisions of the American Taxpayer Relief Act of 2012. The IRS stated that most
taxpayers would be able to file their tax returns beginning January 30, 2013—one week
later than the originally planned date of January 22, 2013. However, as previously
noted, some taxpayers were further delayed because several tax forms required
more extensive programming changes as a result of provisions included in the recent
legislation. According to the IRS, the impact would be minimized because taxpayers
claiming credits related to these forms generally do not file until later in
the filing season. The forms requiring more extensive programming included:

Although it originally planned to process tax returns
claiming education credits beginning January 30, 2013, the IRS announced on
January 28, 2013, that taxpayers filing tax returns that included a Form 8863, Education
Credits (American Opportunity and Lifetime Learning Credits), would not be able
to file their tax return until mid-February. The IRS identified problems
during filing season computer program testing with this form, and the delay was
needed to fix the programming errors in its processing system. Taxpayers could
begin filing tax returns with a Form 8863 on February 14, 2013. However, once the
IRS began receiving tax returns with a Form 8863, they identified additional processing
problems. On March 12, 2013, the IRS announced that errors in a limited number
of software products would further delay the processing of tax returns for some taxpayers who filed with a Form 8863 between February
14 and 22, 2013.

According to the IRS, the software
error affected 583,848 (25 percent) of the more than 2.3 million tax
returns claiming the AOTC during this period. IRS management informed us that
beginning with the 2013 Filing Season, the IRS required software companies to
transmit a “yes” or “no” to specific questions on Form 8863 related to the
AOTC. These questions relate to specific requirements that need to be met to
qualify for the credit. A limited number of e-file software companies
incorrectly programmed the form to replace a “no” answer with a blank when
transmitting the tax returns to the IRS. As a result, these tax returns were
identified by the IRS’s error processes as having an incomplete Form 8863 (IRS
programming requires either a yes or no; the field cannot be blank).

Once the error is identified, the
IRS suspends processing of the tax return and corresponds with the taxpayer to
obtain the missing information. The IRS originally estimated the time for taxpayer
response and correction of the missing information could take up to eight
weeks. However, on March 26, 2013, the IRS announced that due to the
steps it took to help taxpayers affected by the software errors, it was able to
resolve these cases more quickly than anticipated—in two to four weeks.

As of May 9, 2013, IRS management
indicated that approximately 7,000 of the 583,848 taxpayers whose tax returns were originally delayed still had not
received their tax refund. IRS management stated that once the IRS corrected
the errors caused by the blank fields in the Form 8863, the tax returns
continued through the IRS’s tax return verification processes. If these verification
processes identified additional errors on the tax return, a further delay would
result.

The e-filing rate and the use of home
computers increased, whereas the use of the Free File Program decreased

As of May 4, 2013, e-file volumes were 1.6 percent higher
than the volumes for the same period in the 2012 Filing Season. More taxpayers
are preparing their own tax returns using a home computer. For example, as of
May 4, 2013, 38.3 percent of taxpayers used a home computer to e-file
their tax return compared to 37.3 percent for the same period in the 2012
Filing Season. In addition, the number of individuals using the IRS’s Free
File Fillable Forms to file their tax returns is also increasing. The Fillable
Forms opens up the Free File Program to nearly everyone, with no income
limitations. Use of Fillable Forms has increased to 457,555 tax returns, an
increase of 0.3 percent from the 2012 Filing Season.

However, participation in the Free File Program decreased by
5.3 percent when compared to the same period in the 2012 Filing Season. The
traditional IRS Free File Program is a free Federal online tax preparation and
e-filingprogram that enables eligible taxpayers to use commercial tax
software accessible for free through the IRS’s website, IRS.gov. The Free File
Program was developed through a partnership between the IRS and the Free File
Alliance, LLC (a group of private-sector tax preparation companies).

The use of the savings bond
and split refund options has declined, and some individuals may be misusing the
split refund option

Through May 2, 2013, a total of 38,692 individuals requested
to convert tax refunds totaling more than $21.6 million into savings bonds.
This represents an 8.3 percent decrease in the number of taxpayers when
compared to the same period during Processing Year 2012. In addition, 766,465 individuals,
an 11.7 percent decrease from Processing Year 2012, chose to split tax refunds
totaling more than $3.2 billion between two or three different checking and
savings accounts. Figure 2 shows a comparison of taxpayers’ use of the split
refund and savings bond options for Processing Years 2012 and 2013 as of May 2,
2013.

Figure 2: Use of Savings
Bonds and Split Refunds for
Processing Years 2012 and 2013 (as of May 2, 2013)

Source: IRS 2013 Weekly Filing Season reports as of
May 2, 2013. Totals shown are rounded.

In our Interim Filing Season report dated March 29, 2013,[7]we reported that our
preliminary analysis of Form 8888, Allocation of Refund (Including Savings
Bond Purchases), raised concerns about the potential misuse of the split
refund option to direct multiple tax refunds to the same bank account. Form
8888 instructions state that the form is to be used only for the deposit of a
tax refund to an account in the taxpayer’s name. Taxpayers are not to use Form
8888 to direct a portion of a tax refund to a tax return preparer for payment
of services rendered or any other purpose. We notified the IRS on February 8,
2013, that it appears tax refunds are being directed to tax return preparer
accounts and provided the IRS with the 452 paid tax return preparers associated
with 248,027 multiple direct deposits for review. In response, the IRS
indicated that it would review tax return preparer data and take necessary
enforcement actions.

Since that time, the number of multiple split refunds to the
same account increased. As of May 2, 2013, taxpayers filed 385,591 tax
returns with a Form 8888 requesting direct deposits totaling more than $150.8 million
into 46,897 bank accounts. Each of the 46,897 bank accounts we identified had
three or more Form 8888 deposits from different taxpayers into these accounts.
We determined that 248,027 (64 percent) of the 385,591 tax returns were
prepared by a paid tax return preparer. On June 24, 2013, IRS management indicated
that they were still in the process of reviewing the initial 452 tax return
preparers we identified in February 2013 to determine their level of abuse of
Form 8888. IRS management indicated that once these reviews are completed, they
will educate tax return preparers on the proper use of Form 8888 and will take
further action to address the most egregious offenders.

Evaluation of tax provisions
affected by the American Taxpayer Relief Act of 2012

The
American Taxpayer Relief Act of 2012 extended a number of expiring tax
provisions. Our analysis of the following tax provisions found that the IRS
adequately addressed the changes to these provisions in its tax products,
computer system programming, and processing guidance:

·Deduction for State and local general sales taxes.

·Deduction for teachers’ classroom expenses.

·The additional $1,000 added to the inflation‑adjusted
adoption credit and expiration of the refundable portion of the credit.

As of May 4, 2013, the IRS reported that it had identified 579,183
tax returns with $3.6 billion claimed in fraudulent refunds during tax return
processing and prevented the issuance of $3.47 billion (96.4 percent)
of those refunds. Although this is a decrease in the number of fraudulent tax
refunds the IRS identified as of the same period in Processing Year 2012, the decrease
results from the IRS’s expanding efforts to identify and prevent fraudulent tax
returns from ever being processed. Figure 3 shows the number of fraudulent tax
returns identified by the IRS for Processing Years 2010 through 2012 as
well as the refund amounts that were claimed and stopped.

Figure 3: Fraudulent
Returns and Refunds Identified
and Stopped in Processing Years 2010 Through 2012

During tax return processing,
paper and e‑filed tax returns are analyzed through various Electronic
Fraud Detection System (EFDS) data model formulas. The data models identify
suspicious paper and e-filed tax returns based on specific characteristics of
the tax return. An associated score is computed for each tax return. The
higher the score, the greater the likelihood that the tax return is fraudulent.
For those tax returns meeting a certain score, the tax return is sent to an IRS
tax examiner to screen the tax return for fraud potential. If a tax return is
selected for further verification, the tax refund is held until employers or
third parties are contacted to verify wage information on the tax return. If
the verification process is not completed within a certain time period, the tax
refund is automatically released.

Beginning in Fiscal Year 2011, the IRS began issuing Identity
Protection Personal Identification Numbers (IP PIN) to assist identity theft
victims in the filing of their tax returns. For the 2013 Filing Season,
the IRS reports that it issued approximately 759,000 IP PINs. The IP PIN
indicates that the taxpayer was a victim of identity theft and has previously
provided the IRS with information that validates his or her identity and that
the IRS is satisfied that the taxpayer is the valid holder of the Social
Security Number. Tax returns filed with a valid IP PIN will be processed using
standard processing procedures, including issuing any refunds, if applicable. However,
if a valid IP PIN is not provided on the tax return, it will not be processed.
For example, if a valid IP PIN is not provided on an e-filed tax return, it
will be rejected (the IRS will not accept the tax return for processing). As
of April 30, 2013, the IRS had rejected approximately 380,000 tax returns as a
result of an incorrect or missing IP PIN. A new IP PIN will be issued each
year before the start of the new filing season for as long as the taxpayer
remains at risk of identity theft.

The IRS is also continuing to expand the number of tax
accounts that it locks by placing an identity theft indicator on the account. Between
January 2011 and May 2013, the IRS locked approximately 10 million taxpayer
accounts. E-filed tax returns using the Social Security Number of a locked account
will be rejected. As of April 30, 2013, the IRS has rejected 73,791 e-filed
tax returns that used a Social Security Number of a locked account.

The IRS first developed 11 identity theft filters for use in
Processing Year 2012.[8] The number of
filters increased to more than 80 for use in the 2013 Filing Season, and as of May
30, 2013, the IRS identified 151,010 tax returns and prevented
approximately $840 million in fraudulent tax refunds from being issued. The
filters are used to identify potentially fraudulent tax returns and prevent the
issuance of refunds at the time tax returns are being processed. The identity
theft filters incorporate criteria based on characteristics of confirmed
identity theft tax returns. These characteristics include amounts claimed for
income and withholding, filing requirements, prisoner status, taxpayer age, and
filing history. Tax returns identified via the filters are held during
processing until the IRS can verify the taxpayer’s identity. If the
individual’s identity cannot be confirmed, the IRS removes the tax return from
processing. This prevents the issuance of a fraudulent tax refund. We conducted
a separate review of the IRS’s efforts to detect and prevent identity theft.

In addition, as of May 4, 2013, the IRS reported that it identified
149,527 potentially fraudulent prisoner tax returns for screening. The tax
refunds claimed on these prisoner tax returns totaled approximately $185 million.
We are in the process of conducting a separate review of the IRS’s efforts to
improve the detection and prevention of prisoner tax fraud.

Due to EFDS programming errors, some tax
returns were not scored for fraud

In a separate review of the IRS’s wage and withholding
verification process, we identified 320 Tax Year 2010 tax returns that
should have been sent through the EFDS but did not receive an EFDS score.[9] We brought this to the IRS’s
attention, and the IRS determined that errors in the processes it used to load
tax return data into the EFDS resulted in some tax returns not receiving an
EFDS fraud score. The IRS issued an alert on March 1, 2013, indicating that,
as a result of these errors, 332,835 Tax Year 2012 paper tax returns had
not received an EFDS score. IRS management indicated that programming changes
were made at the beginning of the 2013 Filing Season to address the
problems we identified for e-filed returns. The IRS stated that the
programming errors which affected paper tax returns were corrected by the end
of March 2013 and that the 332,835 Tax Year 2012 paper tax returns were
subsequently sent through EFDS and received an EFDS score, resulting in the
prevention of more than $1 million in fraudulent tax refunds.

Taxpayers have several options to
choose from when they need assistance from the IRS, including telephone
assistance through the toll-free telephone lines, face-to-face assistance at
the Taxpayer Assistance Centers and Volunteer Program sites, and
self-assistance through IRS.gov and social media channels. The use of
self-assistance options has grown significantly as taxpayers seek information
and assistance through these channels. In comparison, declining IRS resources
reduced the number of taxpayers that the IRS estimated it could assist at Taxpayer
Assistance Centers.

Self-assistance options – 24
hours a day, seven days a week

The IRS is committed to helping taxpayers obtain the
information they need to comply with the tax law. This includes offering more
self-assistance options that taxpayers can access 24 hours a day, seven
days a week. For example, the IRS offers IRS2Go, which is a mobile application
that lets taxpayers interact with the IRS using their mobile device to access
information and a limited number of IRS tools. In addition, the IRS provides
information via various forms of social media including YouTube, Twitter,
Tumblr, and Facebook. As of May 2, 2013, there were more than 2 million new
downloads of the IRS2Go phone app, and more than 1.8 million new views of IRS
YouTube videos. In addition, the number of Twitter followers increased 30
percent.

In addition, as of May 4, 2013, the IRS reported a 24.7percent
increase in the number of visits to IRS.gov over the same period in the 2012 Filing
Season. It also reported a 55.6percent increase in the number of
taxpayers obtaining their refund information online via the “Where’s My Refund?”feature found on IRS.gov. Figure
4 shows the year‑to‑date comparisons. The
IRS continues to expand its online tools to assist taxpayers. For example, the
IRS now offers a First-Time Homebuyer Credit (Homebuyer Credit) Account Look‑Up
feature on IRS.gov. This feature allows taxpayers to see the total amount of
Homebuyer Credit they received, the amount they have paid back to date, the
balance of their Homebuyer Credit, and their annual installment repayment
amount. The Look‑Up feature helps taxpayers determine whether they need to
include any Homebuyer Credit repayment on their current year tax return.

“Where’s My Refund” tool did not always provide
accurate refund status information early in the filing season.
We identified that the “Where’s My Refund?” tool did not consistently provide accurate refund status information to some
taxpayers who filed early in the 2013 Filing Season. The IRS indicated that it
had identified this issue on February 12, 2013, which resulted from a computer
programming error incorrectly overwriting the refund date. The IRS indicated
that the issue was corrected on March 14, 2013, and no new occurrences had
been reported. While updates could not be made to accounts that received the
incorrect message prior to the programming correction, the IRS expected the
impact on affected taxpayers to be minimal because those taxpayers had already
received their refunds. Our review of 62 tax returns received between March 2
and 15, 2013, confirmed that the “Where’s My Refund?” tool provided accurate
information and correctly noted that the tax refunds had been issued for all 62 tax
returns.

Face-to-face assistance provided at the
Taxpayer Assistance Centers

The IRS assisted approximately 6.8 million taxpayers during Fiscal
Year 2012 and plans to assist six million taxpayers in Fiscal Year 2013. This
represents 11.8 percent fewer taxpayers than were assisted in Fiscal Year 2012.
The Fiscal Year 2013 plan was based on the assumption of limited seasonal
staff support and the continuing reduction of permanent staff as a result of
the hiring freeze and buy-out authority. Figure 5 shows the number of contacts
by product line at the Taxpayer Assistance Centers for Fiscal Years 2010
through 2013.

Through May 4, 2013, the IRS received approximately 92.8
million attempts from taxpayers calling the various toll-free telephone
assistance lines seeking help in understanding the tax law and meeting their
tax obligations.[12] IRS assistors answered more
than 15.6 million calls and have achieved a 69.8 percent Level of Service[13]with a 14.1 minute Average
Speed of Answer. The Level of Service for Fiscal Year 2012 was 67.8 percent. Figure
6 shows a comparison of IRS toll-free telephone statistics through May 4, 2013,
for Fiscal Years 2010 through 2013.

Figure 6: Toll-Free
Telephone Statistics for
Fiscal Years 2010 Through 2013 (as of May 4, 2013)

Statistic

Fiscal Year

2010

2011

2012

2013

Calls Answered

17,947,725

17,607,007

14,620,233

15,609,615

Level of Service

76.0%

74.1%

67.8%

69.8%

Average Speed of Answer (seconds)

569

622

975

848

Source: IRS management information reports as of May
4, 2013.

Tax preparation assistance at Volunteer
Program sites

The Volunteer Program continues to play an important role in
the IRS’s efforts to improve taxpayer service and facilitate participation in
the tax system. It provides no-cost Federal tax return preparation and
e-filing to underserved taxpayer segments, including low-income, elderly,
persons with disabilities, rural, Native Americans, and limited-English-proficient
taxpayers. As of May 4, 2013, more than three million tax returns have been
prepared at the 13,081 Volunteer Program sites nationwide. Figure 7 shows the
number of tax returns prepared by volunteers from Fiscal Years 2011 through 2013.

Figure 7: Volunteer
Program Statistics
for Fiscal Years 2011 Through 2013

We conducted a separate review of the accuracy of tax return
preparation at Volunteer Program sites. We visited 39 Volunteer Income Tax
Assistance and Tax Counseling for the Elderly sites to determine if taxpayers
receive quality service, including accurate preparation of their individual
income tax returns. We developed scenarios designed to test quality controls
and training the volunteers received in preparation for the 2013 Filing Season.

Each year the IRS estimates that $11 to $13 billion in
Earned Income Tax Credits (EITC) are improperly paid and estimates that two-thirds
of all the EITC claims are prepared with the assistance of a paid tax return
preparer. Analysis of the more than
14.4 million tax returns with an EITC claim that were prepared by a paid tax
return preparer as of May 2, 2013, identified 708,298 (5 percent) tax
returns claiming more than $2 billion in the EITC where the IRS determined that
the tax return preparer either did not include the required Form 8867, Paid
Preparer’s Earned Income Credit Checklist,or included an incomplete
Form 8867. These 708,298 tax returns were prepared by 122,133 tax return
preparers who continue to not comply with EITC due diligence requirements.

Beginning with the 2012 Filing
Season, paid tax return preparers who prepare a tax return claiming the EITC
must include Form 8867 with the tax return. Preparers who do not adhere to
this requirement can be assessed a $500 due diligence penalty for each tax
return they submit without the required Form 8867:

·Internal Revenue Code Section 6695(g) states: Any person who is a tax
return preparer with respect to any return or claim for refund who fails to
comply with due diligence requirements imposed by the Secretary by regulations
with respect to determining eligibility for, or the amount of, the credit
allowable by section 32 shall pay a penalty of $500 for each such failure.

·Section 1.6695–2 of Title 26 of the Code of Federal Regulations
states: The tax return preparer must complete Form 8867, Paid Preparer’s
Earned Income Credit Checklist, or such other form and such other information
as may be prescribed by the Internal Revenue Service.

·Form 8867 states: If you checked “No” on line 20, 21, 22, 23, 24, or
25, you have not complied with all the due diligence requirements and may have
to pay a $500 penalty for each failure to comply.

The noncompliance we identified in
the 2013 Filing Season is what we also reported in our 2012 Filing Season
report.[15] We
reported that, as of May 3, 2012, almost 534,000 (4 percent) tax returns with
EITC claims totaling more than $1.5 billion were filed without the required Form 8867.
IRS management indicated that the new
requirement did not become effective until December 20, 2011, and although the
IRS had taken immediate steps to communicate the requirement to the preparer
community, it is possible the message was not fully disseminated before the
filing season began. No penalties were assessed against tax return preparers
who were noncompliant in the 2012 Filing Season. The IRS indicated that it
planned to assess penalties for noncompliance for Tax Year 2012 returns.

For
the 708,298 Tax Year 2012 tax returns identified, the potential penalties that
can be assessed as a result of not including the required Form 8867 total more
than $354 million. Figure 8 shows the results of our analysis of paid tax
return preparers potentially subject to the EITC due diligence penalty as of
May 2, 2013.

Source: Our analysis
of tax return information in the Individual Return Transaction File as of May
2, 2013.

At the start of the 2013 Filing Season, the IRS indicated that as a result of its extensive outreach
to software developers and the tax return preparer community prior to the start
of the filing season, it believed few, if any, paid tax return preparers would
fail to comply with the new due diligence reporting requirement. These efforts
included the issuance of almost 5,000 warning
notices to paid tax return preparers who were noncompliant with the Form 8867
requirement in Processing Year 2012. The IRS
also indicated that it will identify Tax Year 2012 tax returns prepared
by a paid tax return preparer with a claim for the EITC and no Form 8867
throughout the 2013 Filing Season and will assess penalties against the paid
tax return preparers at the completion of the filing season.

On January 15, 2013, we notified
the IRS of our concerns with its plans for assessing the due diligence
penalty. We suggested that the IRS establish a process to notify noncompliant
tax return preparers early in the filing season to allow them to become
compliant and thus reduce the amount of the penalty that they could ultimately
be assessed. On February 14, 2013, we provided the IRS with a list of 10,345 tax
return preparers who were not in compliance with the EITC due diligence
requirement of including a completed Form 8867 with the tax return. IRS
management notified us on March 18, 2013, that in reviewing the tax return
preparers we provided, they identified that some of the missing or incomplete
Forms 8867 may be the result of errors in some of the tax preparation software preparers
are using. However, the IRS was unable to determine which preparers may have
been affected by these errors.

As of June 24, 2013, the IRS
stated that it was considering a number of options for assessing the due
diligence penalty but had not yet determined how to proceed. The IRS also
stated that it does not have a firm date as to when it will assess the due
diligence penalties. The IRS indicated that its goal is to assess applicable
penalties before the next filing season, “as long as time and resources allow
for it.”

Recommendation

Recommendation
1:The Commissioner, Wage
and Investment Division, should ensure that the EITC due diligence penalty is assessed
against tax return preparers who did not comply with the requirement to attach
a Form 8867 to tax returns with a claim for the EITC.

Management’s Response:The IRS agreed with this recommendation and will complete its
analysis of the Tax Year 2012 returns that were prepared by paid tax return
preparers and did not have the required Form 8867. The IRS indicated that it
will assert the penalty for failure to comply with EITC due diligence
requirements in those cases where Letter 4989, You Submitted 2011 Credit
Returns with EITC Without Attaching Form 8867, was issued and the preparer
remained noncompliant in the 2013 Filing Season. To effectively manage
resources and administer the penalty in a balanced and uniform manner, the IRS
indicated that it will assert penalties on those preparers whose noncompliance
is determined to be egregious or habitual.

The IRS disagreed with our outcome measure of $354
million in EITC due diligence penalties. It believes that the amount
associated with EITC due diligence penalties is lower than we estimated because
it includes preparers whose noncompliance resulted from technical issues.

Office of Audit Comment:While the IRS agreed with our recommendation, it plans to
limit the assessment of penalties to only those preparers who were also
delinquent in meeting due diligence requirements in the 2012 Filing Season and
whose noncompliance is determined to be egregious or habitual. This is despite
the fact that the IRS has conducted extensive education and outreach to the tax
return preparer and software provider communities since the requirement to
provide Form 8867 became effective in December 2011. The IRS expended
significant resources to ensure that tax return preparers were knowledgeable
about the EITC due diligence requirements.

The IRS disagreed with our outcome measure because it
believes that some tax preparer noncompliance was caused by technical issues.
During our audit, the IRS indicated that some of the tax return preparers we
identified were affected by a tax preparation software error that resulted in
the Form 8867 not being transmitted to the IRS or an incomplete Form 8867 being
transmitted. However, as stated in our report, the IRS did not provide
documentation during our review identifying those tax return preparers whose
noncompliance was the result of a tax preparation software error.

Our analysis of the processing of education credit claims
filed on Tax Year 2012 tax returns found that the IRS is continuing to allow
credits for students who are unlikely to be enrolled in a post-secondary
education program. As of May 2, 2013, 42,961 taxpayers received questionable
education credits totaling approximately $58.5 million for students under the
age of 14 and over the age of 65. We identified that:

15,208 taxpayers received more than $21.5 million in
questionable AOTC credits. These taxpayers claimed AOTCs totaling nearly $13.3
million for students under the age of 14 and $8.2 million for students
over the age of 65.

12,171 taxpayers received more than $3.5 million in
questionable Lifetime Learning Credits. These taxpayers claimed Lifetime
Learning Credits totaling almost $1 million for students under the age of
14 and $2.5 million for students over the age of 65.

15,582 taxpayers received questionable AOTC and Lifetime
Learning Credits. These taxpayers received more than $16.3 million in
questionable AOTC credits—more than $9.7 million for students under the
age of 14 and more than $6.6 million for students over the age of 65.
These taxpayers also received more than $17.2 million in questionable
Lifetime Learning Credits—more than $9.9 million for students under the
age of 14 and more than $7.3 million for students over the age of 65.

Education credits include the AOTC and the Lifetime Learning
Credit. The AOTC was created by the American Recovery and Reinvestment Act of
2009[16] (the Recovery Act)
and is a refundable tax credit available for higher education expenses up to
$4,000 for Tax Years 2009 and 2010. The maximum AOTC is $2,500 per student,
and the first 40 percent of the credit (up to $1,000) is fully refundable.
Taxpayers can receive the credit only for students who attend at least
half-time for at least one academic period and are pursuing a four-year degree
or vocational certification.[17] The American Taxpayer Relief
Act of 2012 extended the AOTC through December 2017. The Lifetime Learning
Credit, enacted in 1997 as part of the Taxpayer Relief Act,[18]
is open to anyone taking at least one college or vocational course who meets
the income eligibility requirements. The qualifying person does not have to be
pursuing a degree and there is no minimum number of credit hours required.

In our 2012 Filing Season report,[19]we reported that 109,618
taxpayers received AOTCs totaling more than $159 million in Tax Year 2011 for
students who, based on their age, are unlikely to be enrolled in a four-year
college degree or vocational education program. In response to our review, the
IRS developed filters to identify questionable claims for the AOTC based on the
age of the student. The IRS also revised Form 8863 to require detailed
information about the educational institution each student attended. In
addition, the IRS indicated that it would use the Automated Questionable Credit
program to initiate correspondence to taxpayers and, if appropriate, issue the requisite
Statutory Notices of Deficiency to disallow erroneous credit claims before
payment. For those cases that are not appropriate for resolution through the
Automated Questionable Credit program, the IRS planned to continue to use
existing examination resources to supplement its efforts to address erroneous
claims.

On February 28, 2013, we notified the IRS that taxpayers
were continuing to receive education credits for students whose age indicates
it is not likely they are attending college. IRS management agreed. According
to IRS management, the filters they implemented in response to our 2012 Filing
Season report did not identify all instances where taxpayers claimed students
who, based on their age, are not likely attending college. IRS management also
stated that the IRS recognizes the importance of identifying and reviewing
questionable AOTC claims based on the student’s age. However, the IRS does not
have the authority to deny the AOTC during tax return processing based solely
on the student’s age. We plan to conduct a separate review of the IRS’s
efforts to detect and prevent questionable education credit claims.

Recommendations

The Commissioner, Wage and
Investment Division, should:

Recommendation 2:Update filters
to ensure that all instances in which taxpayers claim students whose age
indicates it is not likely they are attending college are identified during tax
return processing as a potentially questionable education credit claim.

Management’s Response:The IRS agreed with this recommendation. The IRS has
implemented filters and business rules during return processing that consider
the age of students for whom education credits are claimed. Business rules are
also in place and used by the Compliance function to evaluate student ages when
considering tax returns to be selected for audit. The processing and
post-processing filters and business rules are frequently evaluated to ensure
effectiveness and balance in identifying fraudulent or erroneous claims without
unduly flagging those claims most likely to be accurate. The IRS disagreed
with our outcome measures of potentially erroneous AOTC and Lifetime Learning
Credits, stating that the age of the student is only one attribute to be
considered when evaluating the potential for an erroneous or fraudulent
claim.

Office of Audit Comment:Although
the IRS agreed with this recommendation, its response shows that corrective
actions have already been taken to address the concerns we raised. However, we
disagree that the actions taken are effective in identifying education credits
claimed for students whose age indicates it is unlikely they are enrolled in secondary
education or vocational training. As of May 2, 2013, we continued to identify
questionable education credits that were not identified by IRS filters and
business rules.

We agree that the age of the
student is only one attribute to be considered when evaluating the potential
for an erroneous or fraudulent claim. However, we believe this is an important
attribute of a potentially erroneous claim. The IRS also agrees that the age
of the student is a significant indicator of potential error or fraud as
demonstrated by the fact that it implemented filters and business rules to
identify these education credit claims in response to similar concerns raised
during our 2012 Filing Season review. The IRS should ensure that the filters
and business rules are working properly.

Recommendation 3:Initiate a program to
recover the more than $58 million from the 42,961 taxpayers who received
education credits for students who were of an unlikely age to be eligible for
the credits.

Management’s Response:The IRS agreed with this recommendation. The Compliance
functions will select a sample set of returns for inclusion in the Fiscal Year
2014 Exam Plan. The results of the sample examinations will be evaluated and
considered in determining if expansion of the sample is an appropriate use of
limited resources or if the issue displaces other work that is more productive.

We have continued to report inaccuracies in the IRS’s processing
of Homebuyer Credit repayments in the results of our filing season reviews
since September 2011. Analysis of Homebuyer Credit repayments processed as of May 2, 2013,
identified 4,184 tax returns for which the IRS refunded a Homebuyer Credit installment
payment as of May 2, 2013. We reviewed a judgmental sample[20]of 138 of these 4,184 tax
returns and found that all of the refunds were correctly issued to taxpayers. However,
the IRS continues to incorrectly assess Homebuyer Credit repayments and incorrectly
calculate the remaining Homebuyer Credit repayment amounts when property is
transferred as a result of a divorce.

Individuals who claimed the Homebuyer Credit for a home
purchased between April 9 and December 31, 2008, are required to repay the
credit in annual installment payments beginning with their Tax Year 2010
return. Taxpayers who received a Homebuyer Credit must also repay the credit,
less any installment payments made, if they dispose of the home or if the home
is no longer used as their primary residence.[21] Figure 9 shows the number of
Homebuyer Credit installments and dispositions the IRS processed as of May 2,
2013.

Figure 9: Homebuyer Credits, Installments,
and Dispositions Processed as of May 2, 2013

Category

Number of Tax Returns

Number of
Individuals

Dollar Amount of
Homebuyer Credit Reported by Taxpayers

Installments

593,339

800,131

$253,022,305

Dispositions

19,659

25,991

$7,885,268

Source: Our analysis of the IRS’s Individual Return
Transaction File as of May 2, 2013.

The IRS continues to
incorrectly assess Homebuyer Credit repayments

We identified 114, 243 tax returns in which the IRS assessed
Homebuyer Credits totaling more than $47 million. The assessments were made
because the repayment amounts shown on the tax returns were lower than the
amounts computed by the IRS. Our analysis of a statistical sample of 383 of
the 114,243 tax returns found that the IRS incorrectly assessed Homebuyer
Credit repayments totaling $32,826 on 99 (26 percent) tax returns. Based on
the results of our review, we estimate that the IRS could have incorrectly
assessed approximately $10.5 million in Homebuyer Credit repayments to 52,031
taxpayers.

On May 7, 2013, we notified the IRS of our continued
identification of erroneous assessments of Homebuyer Credit repayments. IRS
management agreed that repayment assessments were incorrectly posting to
taxpayer’s accounts. IRS management stated that a programming error caused the
incorrect assessment of the additional payment when some taxpayers submitted a Form
5405, Repayment of the First-Time Homebuyer Credit, with their tax
return. In Tax Year 2012, taxpayers making regular installment payments were
instructed to report their annual repayment of the Homebuyer Credit on Line 59b
of the Form 1040, U.S. Individual Income Tax Return. These taxpayers
did not need to complete the Form 5405. However, the IRS did not provide
a specific explanation as to why the presence of the Form 5405 when one was not
required resulted in an additional assessment. IRS management stated that the
IRS has corrected the assessment amounts on the tax returns we provided and
plans to correct the programming error.

While we agree that some of the erroneous assessments we
identified may have been caused by taxpayers submitting the Form 5405 when the
form was not required, not all of the erroneous Homebuyer Credit repayment
assessments occurred for taxpayers who were not required to provide a Form
5405. Of the 99 tax returns we identified with erroneous Homebuyer Credit repayment
assessments, 10 (10 percent) were filed without a Form 5405. In addition, taxpayers
were required to attach the Form 5405 on 17 (17 percent) tax returns because
the taxpayer reported a disposition of the home. On July 15, 2013, we notified
the IRS of our concerns with its assessment of the errors we identified and
requested additional information as to why these errors may have occurred. IRS
management stated that a programming error in the software used by its Error
Resolution System caused certain tax returns with an additional Homebuyer
Credit assessment to not be identified for additional review before the
assessment was processed. IRS management indicated that they have requested
computer programming changes to correct the error for the 2014 Filing Season.
In addition, IRS management stated that they will take steps to identify
taxpayers with potentially inappropriate Homebuyer Credit assessments and correct
the taxpayers’ accounts.

Calculation of remaining
Homebuyer Credit repayment amounts continues to be incorrect when property is
transferred as a result of a divorce

Analysis of Homebuyer Credit dispositions processed as of
May 2, 2013, found that the IRS continues to record dispositions resulting from
a divorce incorrectly. We reviewed 2,288 tax accounts associated with 2,157
Tax Year 2012 tax returns the IRS processed as of May 2, 2013, where the
taxpayer reported a disposition resulting from divorce. We identified 239 (10 percent)
of the 2,288 tax accounts where the IRS incorrectly overstated the remaining
Homebuyer Credit repayment amount by $956,576.

When ownership of a home used to claim the Homebuyer Credit
is transferred in a divorce, the credit repayment obligation less any
installment payments that have been made is transferred to the spouse who receives
full ownership of the home. Taxpayers report the transfer
of ownership on Part III, Line 13, Box E, of Form 5405. For example:

Taxpayers
A and B file a joint tax return and claim a $7,500 Homebuyer Credit. Taxpayer A’s
tax account will show a credit repayment obligation of $3,750 and Taxpayer B’s
tax account will show a credit repayment obligation of $3,750. The couple
makes a $500 Homebuyer credit repayment. The IRS credits one-half of the
repayment to each taxpayer. As a result, Taxpayer A’s tax account now shows a
net repayment obligation of $3,500 and Taxpayer B’s tax account now shows a net
repayment obligation of $3,500.

The
couple gets divorced and Taxpayer A transfers ownership of the home to Taxpayer
B. When ownership of the home is transferred, the net repayment obligation for
Taxpayer A is transferred to Taxpayer B. As a result, Taxpayer A’s tax account
will now show a $0 repayment obligation and Taxpayer B’s tax account will
show a $7,000 net repayment obligation.

In September 2012, we reported that the IRS did not
accurately process 66 percent (3,819 tax accounts) of the taxpayer accounts it
had processed as of December 31, 2011, where the taxpayer transferred his or
her ownership of the home to a spouse, e.g.,in the case of a
divorce. The incorrect calculations of the remaining Homebuyer Credit
repayment amounts were overstated for 136 taxpayers by more than $650,000 and
understated for 3,683 taxpayers by more than $13.1 million. The
overstatements were the result of a computer programming error. The IRS stated
that it would correct the computer programming and correct the tax accounts
processed in error. However, in May 2013, IRS management discovered that although requested programming changes to correct
the error identified last year were made, the requested changes were never implemented.
Management indicated that they are seeking a solution to resolve the issue. In
addition, the IRS is in the process of correcting the 239 taxpayer accounts
with errors we identified this year.

Recommendations

The Commissioner, Wage and Investment Division, should:

Recommendation 4:Correct
the programming error that resulted in the over assessment of an estimated $10.5
million in Homebuyer Credit installment payments to 52,031 taxpayers and
continue to evaluate the remaining erroneous assessments we identified and take
action to correct any conditions identified.

Management’s Response:The IRS agreed with this recommendation. Programming
changes to resolve the errors that led to the erroneous Homebuyer Credit
assessments have been identified and are expected to be implemented for the
2014 Filing Season. It should be noted, however, that programming changes are
dependent upon Information Technology resource availability and Service-wide
technology priorities. The IRS will continue to evaluate erroneous assessments
that were made and ensure the accounts are adjusted appropriately.

Recommendation 5:Ensure
that actions are taken to implement computer programming changes to address
errors identified during the 2012 Filing Season to prevent the continued errors
in processing Homebuyer Credit dispositions.

Management’s Response:The IRS agreed with this recommendation. Programming
changes to resolve the errors that led to incorrect processing of Homebuyer
Credit information when dispositions occurred are expected to be implemented
for the 2014 Filing Season. It should be noted, however, that programming
changes are dependent upon Information Technology resource availability and
Service-wide technology priorities. The IRS will continue to evaluate
erroneous assessments that were made and ensure that the accounts are adjusted
appropriately.

Recommendation 6:Initiate a program to
correct the 239 taxpayers’ accounts where the IRS incorrectly recorded the
transfer of the net Homebuyer Credit repayment obligation in the case of a
divorce.

Management’s Response:The IRS agreed with this recommendation. The IRS is
obtaining an extract of accounts to identify all accounts affected by the
Homebuyer Credit programming errors and will adjust them to reflect their
correct status.

114 (20 percent) taxpayers who claimed credits totaling $348,337
where the vehicle claimed on Form 8936 did not qualify for the credit.

186 (32 percent) taxpayers who claimed credits totaling $827,369
where the description of the vehicle model or model year did not match the
vehicle model or model year indicated by the VIN provided by the taxpayer.

274 (48 percent) taxpayers who claimed credits totaling more
than $1.4 million where the VIN provided on the Form 8936 was less than 17
digits.

On March 26, 2013, we provided the IRS with 65 tax returns
with questionable Plug-in Motor Vehicle Credits for its review. IRS management
agreed that the Plug-in Motor Vehicle Credit was likely being allowed for
nonqualifying vehicles. According to the IRS, processes ensure that a VIN is
provided on Form 8936 and, if provided, that the VIN is alphanumeric. However,
these processes do not ensure that the VIN is 17 characters or that the
characters included in the VIN represent a qualifying vehicle. IRS management
indicated that it would review the most questionable tax returns we identified
and take necessary corrective actions.

The Recovery Act included a number of provisions that
encourage the purchase of motor vehicles (or the conversion of motor vehicles
to those) that operate on clean renewable sources of energy. In January and
September 2011, we reported that taxpayers were claiming erroneous Plug-in
Motor Vehicle Credits.[22] We recommended that the IRS
develop a process to ensure that taxpayers are not erroneously claiming credits
for nonqualifying vehicle makes and models. The IRS agreed with this recommendation
and began requiring the VIN on Form 8936 in the 2012 Filing Season. The
standard VIN is 17 digits long and identifies the vehicle manufacturer,
type, model, and year of manufacture. Figure 10 is an illustration of a
standard VIN.

Figure 10: Standard VIN

World Manufacturer
Identifier

Vehicle Descriptor
Section

Vehicle Identifier
Section

Type of Information Provided

Country

Manufacturer

Type

Details

Check Digit

Year

Assembly Plant

Production Number

VIN Digits

1

2

3

4–8

9

10

11

12–17

Values From Example
VIN 1HGCM82633A004352

1

H

G

CM826

3

3

A

004352

Source: www.carfax.com/vin_decoding.cfx.

Recommendations

The Commissioner, Wage
and Investment Division, should:

Recommendation 7:Establish
procedures to ensure that the VIN provided for each vehicle claimed on Form
8936 is 17 characters long and, using the characteristics of the VIN, ensure that
the vehicle is eligible before allowing the Plug-in Motor Vehicle Credit.

Management’s Response:The IRS partially agreed with this recommendation. The IRS
will be evaluating changes to Form 8936 which will ensure that reported VINs
contain the requisite number of characters. ***********2*****************
*****************************2**********************************
*****************************2**********************************
************************2****************.

Recommendation 8:Initiate
a program to recover the erroneous Plug-in Motor Vehicle Credits the IRS
allowed on the 574 tax returns we identified.

Management’s Response:The IRS agreed with this recommendation. The IRS has
developed a business rule to identify returns claiming the Plug-in Motor
Vehicle Credits for additional review. The Compliance functions will select a
sample set of returns for inclusion in the Fiscal Year 2014 Exam Plan. The
results of the sample examinations will be evaluated and considered in
determining if expansion of the sample is an appropriate use of limited
resources or if the issue displaces other work that is more productive.

Our overall objective was to evaluate whether the IRS timely
and accurately processed individual paper and e-filed tax returns during the
2013 Filing Season. To achieve this objective, we:

I.Identified volumes of paper and e-filed tax returns received through May
4, 2013, from the IRS Weekly Filing Season reports that provided a year-to-date
comparison of scheduled return receipts to actual return receipts. The reports
also provided a comparison to Fiscal Year 2012 receipts for the same period.

III.Determined the status and accuracy of programs planned to be initially
implemented for the 2013 Filing Season.

A.Electronically
identified more than 14.4 million EITC tax returns that were prepared by a paid
preparer. We determined which preparers could be subject to the EITC due diligence
penalty based on tax returns submitted without a Form 8867, Paid Preparer’s Earned Income Credit Checklist.

B.Tested the accuracy of the expanded “Where’s My refund?” application on IRS.gov
by tracking a judgmental sample[23]of 62 returns. A judgmental sample
was selected to validate the accuracy of the program and because we did not
intend to project to the population.

IV.Followed up on findings previously reported by the Treasury Inspector General
for Tax Administration to ensure that the IRS has taken the agreed‑upon
action to resolve the issues.

A.Determined whether
the IRS is inappropriately refunding Homebuyer Credit installment payments to
taxpayers who correctly report the required repayment amounts on their tax
returns by reviewing a judgmental sample of 138 returns that had the
installment payment refunded and determined whether the refund was appropriate.
A judgmental sample was used because we did not intend to project to the
population.

C.Electronically
identified 2,157 returns where the taxpayers reported a disposition resulting
from a divorce. We evaluated the returns to determine whether the IRS
processed the disposition correctly.

D.Electronically determined that 42,961 taxpayers received questionable
education claims totaling approximately $58.5 million for students under the
age of 14 and over the age of 65.

A.Attended weekly
Wage and Investment Division Filing Season Production meetings to keep informed
on any issues occurring nationwide.

B.Monitored the
IRS Submission Processing website, the IRS public website, and other applicable
websites to identify significant issues or new tax legislation passed after the
filing season began that may affect processing of Tax Year 2012 individual tax
returns.

VI.Compiled statistical information that is of interest to external
stakeholders.

A.Obtained
statistics on taxpayers served at the Taxpayer Assistance Centers from the IRS
Field Assistance Office.

B.Reviewed the IRS
Weekly Filing Season reports, which provide a year-to-date comparison of
various Taxpayer Assistance Center activity levels for the 2011 through
2013 Filing Seasons.

VIII.Identified results for the IRS Toll-Free Telephone Assistance Program by
reviewing Performance Templates and Executive Level Summary reports from the
Enterprise Telephone Data Warehouse for the filing season.

IX.Identified results for IRS self-assistance through IRS.gov from the IRS
Weekly Filing Season reports of IRS.gov activity levels for the 2010 through
2013 Filing Seasons.

Data
Reliability

To assess the reliability of computer-processed data,
programmers in the Treasury Inspector General for Tax Administration Office of
Strategic Data Services validated the data that were extracted, and we verified
the data with appropriate documentation. Judgmental samples were selected and
reviewed to ensure that the amounts presented were supported by external
sources. We found the data to be sufficiently reliable.

Internal
controls methodology

Internal controls relate to management’s plans, methods, and
procedures used to meet their mission, goals, and objectives. Internal
controls include the processes and procedures for planning, organizing,
directing, and controlling program operations. They include the systems for
measuring, reporting, and monitoring program performance. We determined the
following internal controls were relevant to our audit objective: the
processes for planning, organizing, directing, and controlling program
operations for the 2013 Filing Season. We accomplished this by monitoring the
IRS weekly production meetings, reviewing IRS procedures, and interviewing IRS
management. We also evaluated the controls that are incorporated directly into
computer applications to help ensure that the validity, completeness, accuracy,
and confidentiality of transactions and data during application processing of
tax returns for the 2013 Filing Season.

This appendix presents detailed information on the
measurable impact that our recommended corrective actions will have on tax
administration. These benefits will be incorporated into our Semiannual Report
to Congress.

Type and Value of Outcome Measure:

·Increased Revenue – Potential; $354,149,000 in EITC due diligence
penalties not assessed on 122,133 tax return preparers who did not include a
Form 8867, Paid Preparer’s Earned Income Credit Checklist, with tax returns claiming the EITC (see page 13).

Methodology Used to Measure the Reported
Benefit:

We computer identified 122,133 tax return preparers who
prepared 708,298 tax returns with EITC claims for which they did not include
the Form 8867 as required. Tax return preparers are subject to a $500 penalty
for each tax return with an EITC claim for which the Form 8867 is not
provided. We estimate that total penalties on the 708,298 tax returns with a
missing or incomplete Form 8867 could total $354,149,000.

Type and Value of Outcome Measure:

·Cost Savings, Funds Put to Better Use – Potential; $37,780,021
from 30,822 taxpayers claiming refundable AOTC in Tax Year 2012 for students
who are of an age at which they are unlikely to be enrolled in a four-year
college or vocational program (see page 16).

Methodology Used to Measure the Reported Benefit:

We identified 30,822 taxpayers who erroneously claimed $37,780,021
in the AOTC on tax returns processed during the period January 1 through May 2,
2013. These taxpayers received tax refunds for the AOTC for students who
are younger than age 14 or older than age 65.

Type and Value of Outcome Measure:

·Revenue Protection – Potential; $20,711,762 from 27,764 taxpayers
claiming Lifetime Learning Credits for Tax Year 2012 for students who are of an
age at which they are unlikely to be enrolled in a four-year college or
vocational program (see page 16).

Methodology Used to
Measure the Reported Benefit:

We computer identified 27,764
taxpayers who erroneously claimed $20,711,762 in Lifetime Learning Credits on
tax returns processed during the period January 1 through May 2, 2013.
These taxpayers received tax refunds for education credits for students who are
younger than age 14 or older than age 65.

Type and Value of Outcome Measure:

·Taxpayer Rights and Entitlements – Potential; 52,031 taxpayers
making their annual First‑Time Homebuyer Credit installment payment were erroneously
assessed $10,477,897 more in Homebuyer Credits than they were required to pay
(see page 19).

Methodology Used to Measure the Reported Benefit:

We computer identified 114,243 tax returns with 190,889
taxpayers who had been manually assessed a Homebuyer Credit repayment amount
for a home purchased in Tax Year 2008. We reviewed a statistically valid
sample of 383 of the returns and found that 99 (26 percent) returns for 163 taxpayers
were erroneously assessed $32,826 more in additional Homebuyer Credits than they
were required to repay.

Based on these results, we estimate that the IRS erroneously
assessed 52,031 taxpayers $10,477,897 more in additional Homebuyer Credits than
they were required to pay. Our taxpayer projection is based on a 95
percent confidence level, a point estimate of 52,031, and a range of 45,223 to
58,839. Our dollar projection is based on a 95 percent confidence level, a
point estimate of $10,477,897, and a range of $8,522,332 to $12,433,462.

Type and Value of Outcome Measure:

·Taxpayer Rights and Entitlements – Potential; 239 accounts
belonging to taxpayers who disposed of their home due to a divorce and had
their remaining Homebuyer Credit repayment amount overstated by $956,576 (see
page 19).

Methodology Used to Measure the Reported Benefit:

We computer identified 2,288 accounts of taxpayers who disposed
of their home due to a divorce and were no longer responsible to repay the Homebuyer
Credit. Our review of the 2,288 taxpayer accounts identified 239 (10
percent) where the IRS overstated the taxpayers’ remaining Homebuyer Credit
repayment amount by $956,576.

The average number of seconds taxpayers waited in the assistor
queue (on hold) before receiving services.

Customer Service Representative Level
of Service

The relative success rate of taxpayers who call for live
assistance on the IRS toll‑free telephone lines.

Earned Income Tax Credit

A refundable Federal tax credit for low-income working
individuals and families.

Electronic Fraud Detection System

An automated system used to maximize fraud detection at the time
tax returns are filed to eliminate the issuance of questionable refunds.

Enterprise Telephone Data Warehouse

The official source for all data related to toll‑free
telephone system measures and indicators.

Facilitated Self‑Assistance

An initiative to provide self‑help assistance kiosks at
Taxpayer Assistance Centers. The kiosks can be used by taxpayers to access
IRS.gov to file their tax returns, print tax forms and publications, or
conduct tax research.

Filing Season

The period from January 1 through mid-April when most individual
income tax returns are filed.

First-Time Homebuyer Credit

A refundable Federal tax credit for individuals who purchase a
home.

Fiscal Year

A 12-consecutive-month period ending on the last day of any
month. The Federal Government’s fiscal year begins on October 1 and ends on
September 30.

Free File

A free Federal tax preparation and e-filing program for eligible
taxpayers developed through a partnership between the IRS and the Free File
Alliance, LLC. The Alliance is a group of private sector tax software
companies.

Individual Return Transaction File

A database the IRS maintains that contains information on the
individual tax returns it receives.

Processing Year

The calendar year in which the return or document is processed
by the IRS.

Sequester

A set of automatic mandatory spending cuts implemented by
Federal law that affect Government outlays.

Submission
Processing Site

The data processing arm of the IRS. The sites process paper and
electronic submissions, correct errors, and forward data to the Computing
Centers for analysis and posting to taxpayer accounts.

Tax Year

The 12-month period for which tax is calculated. For most
individual taxpayers, the tax year is synonymous with the
calendar year.

Taxpayer Assistance Centers

Walk-in sites where taxpayers can obtain answers to both account
and tax law questions as well as receive assistance in preparing their tax
returns.

Volunteer Program

Includes the Volunteer Income Tax Assistance Program, including
the Volunteer Income Tax Assistance Grant Program and the Tax Counseling for
the Elderly Program. The Volunteer Program provides free tax assistance to
persons with low-to-moderate income (generally $50,000 and below), the
elderly, persons with disabilities, and persons with limited-English
proficiency.

SUBJECT: Draft Audit Report -
Late Legislation Delayed the Filing of Tax Returns and Issuance of Refunds for
the 2013 Filing Season (Audit# 201340010)

We appreciate the opportunity to review
the draft report on the challenges the IRS faced and overcame in successfully
executing the 2013 Filing Season. Despite tax legislation enacted on January
2, 2013, we programmed and tested our return processing systems within an
extremely compressed timeframe and opened the Filing Season for most taxpayers
only one week later than originally planned. Once we were able to accept and
process returns, the actual processing time and length of time for taxpayers to
receive their refunds remained within our target timeframes. Most taxpayers
received their refunds within 21 days or less from the time their returns were
filed.

In addition, we successfully used the
Modernized e-File system as our sole platform for processing electronic
returns. As of August 23, 2013, we had received more than 117 million
electronic individual income tax returns and achieved an e-File rate in excess
of 84 percent. We have also experienced gains in our ability to detect and stop
fraudulent tax returns before they are processed. By proactively identifying
and flagging the accounts of individuals most vulnerable to identity theft, and
by substantially expanding our fraud detection processes, more fraudulent
returns are being removed from the processing system. This results in better
protection for potential victims and a reduction of the risks and costs borne
by the IRS.

We also expanded our efforts to reduce the
payment of erroneous claims for the Earned Income Tax Credit (EITC). Final
regulations addressing the requirement for paid tax return preparers to include
Form 8867, Paid Preparer's Earned Income Credit Checklist, with returns
claiming EITC, were issued in late December 2011. The IRS quickly expanded its
outreach program to educate the practitioner community. The outreach
activities included specifically notifying 5,000 EITC preparers who had not
included Form 8867 with the Tax Year 2011 returns they prepared. We also
worked with the software development community to ensure the Form 8867 was
available for Tax Year 2012 return preparation software products. Despite
these efforts, systemic issues were discovered that caused Form 8867 to appear
incomplete or missing from some software products. We worked with the software
vendors to resolve the problem; however, the data set for those Tax Year 2012
returns whose paid preparers may be subject to the due diligence penalty does
not have an accuracy level sufficient for the IRS to assert the penalty without
additional analysis.

Our in-process review of returns that
meet our penalty criteria has found that 65,749 returns, prepared by 2,474
paid return preparers, claiming $151.6 million of EITC hadno Form 8867
attached to the return. This is significantly less than the 158,348 returns,
prepared by 52,826 preparers, claiming $362 million of EITC, as reported by the
Treasury Inspector General for Tax Administration (TIGTA). Consequently, we do
not agree with the associated Outcome Measure of $354 million, as it is
overstated. When our analysis is completed, we will pursue penalty assertion
for those previously non­compliant return preparers who were notified of the
due diligence requirements. With the resolution of technical issues affecting
the penalty administration, we are prepared to fully enforce the due diligence
provisions in the upcoming 2014 Filing Season.

We also disagree with the $37.7 million
Outcome Measure associated with the American Opportunity Tax Credit and the
$20.7 million Outcome Measure associated with the Lifetime Learning Credit
claimed for Tax Year 2012 by students who are of an age at which they are
unlikely to be enrolled in a four-year college or vocational program. The law
providing the education credits and defining student eligibility does not
establish minimum ages, maximum ages, or likely ages at which students may
qualify for the credits. While student age is one attribute to be considered
when evaluating the potential for an erroneous or fraudulent claim, it cannot
be the sole determinant. Establishing a likely age for pursuing post-secondary
education is subjective. The IRS does consider the age of students, along with
other criteria, as part of a comprehensive screening process to evaluate the
fraud potential of the entire return and to stop those refunds from being
issued when additional scrutiny is deemed necessary. The student age is also
considered in a post-processing environment when returns are scored for audit
potential. The macro-level data analysis performed by the TIGTA did not take
the next step of contacting taxpayers to ascertain facts and circumstances, and
determine whether their credit claims were legitimate or not.

Attached are our comments to your
recommendations. If you have any questions, please contact me, or a member of
your staff may contact Pete Stipek, Director, Customer Account Services, Wage
and Investment Division, at (404) 338-8910.

Attachment

Attachment

RECOMMENDATION 1

The Commissioner, Wage and Investment
Division, should ensure that the EITC due diligence penalty is assessed against
tax return preparers who did not comply with the requirement to attach a Form
8867 to tax returns with a claim for the EITC.

CORRECTIVE ACTION

We will complete our analysis of the Tax
Year 2012 returns that were prepared by paid tax return preparers and did not
have the required Form 8867, Paid Preparer's Earned Income Credit
Checklist. The penalty for failure to comply with due diligence
requirements when determining eligibility for the Earned Income Credit will be
asserted in those cases where Letter 4989, You Submitted 2011 Client Returns
with EITC Without Attaching Form 8867, was issued and the preparer remained
non-compliant in the 2013 Filing Season. To effectively manage resources and
administer the penalty in a balanced and uniform manner, penalties will be
asserted against those preparers determined to be egregious or habitual.

We will monitor this corrective action as
part of our internal management control system.

Recommendations

The Commissioner, Wage and Investment
Division, should:

RECOMMENDATION 2

Update filters to ensure that all
instances in which taxpayers claim students whose age indicates it is not
likely they are attending college are identified during tax return processing
as a potentially questionable education credit claim.

CORRECTIVE ACTION

The IRS has implemented filters and
business rules during return processing that consider the age of students for
whom education credits are claimed. The age of students is a factor that
contributes to the determination of fraud probability, but is not a reliable
sole determinant of erroneous claims. The statute authorizing education
credits and defining eligibility criteria does not impose age limits or
otherwise indicate likely ages for qualification. Business rules are also in
place, and used by the Compliance function, to evaluate student ages when
considering tax returns to be selected for audit.

The processing and post-processing filters
and business rules are frequently evaluated to ensure effectiveness and balance
in identifying fraudulent or erroneous claims without unduly flagging those
claims most likely to be accurate.

Initiate a program to recover the more
than $58 million from the 42,961 taxpayers who received education credits for
students who were of an unlikely age to be eligible for the credits.

CORRECTIVE ACTION

The Compliance functions will select a
sample set of returns for inclusion in the Fiscal Year 2014 Exam Plan. The
results of the sample examinations will be evaluated and considered in
determining if expansion of the sample is an appropriate use of limited
resources, or if the issue displaces other work that is more productive.

We will monitor this corrective action as
part of our internal management control system.

Recommendations

The Commissioner, Wage and Investment
Division, should:

RECOMMENDATION 4

Correct the programming error that
resulted in the over assessment of an estimated $10.5 million in Homebuyer
Credit installment payments to 52,031 taxpayers and continue to evaluate the
remaining erroneous assessments we identified and take action to correct any
conditions identified.

CORRECTIVE ACTION

Programming changes to resolve the errors
that led to the erroneous Homebuyer Credit assessments have been identified and
are expected to be implemented for the 2014 Filing Season. It should be noted
however, that programming changes are dependent upon Information Technology
resource availability and Servicewide technology priorities. We will continue
to evaluate erroneous assessments that were made and ensure the accounts are
adjusted appropriately.

We will monitor this corrective action as
part of our internal management control system.

RECOMMENDATION 5

Ensure that actions are taken to implement
computer programming changes to address errors identified during the 2012
Filing Season to prevent the continued errors in processing Homebuyer Credit
dispositions.

CORRECTIVE ACTION

Programming changes to resolve the errors
that led to incorrect processing of Homebuyer Credit information when
dispositions occurred are expected to be implemented for the 2014 Filing
Season. It should be noted however, that programming changes are dependent
upon Information Technology resource availability and Servicewide technology
priorities. We will continue to evaluate erroneous assessments that were made
and ensure the accounts are adjusted appropriately.

We will monitor this corrective action as
part of our internal management control system.

RECOMMENDATION 6

Initiate a program to correct the 239
taxpayers’ accounts where the IRS incorrectly recorded the transfer of the net
Homebuyer Credit repayment obligation in the case of a divorce.

CORRECTIVE ACTION

We are obtaining an extract of accounts
from the Master File to identify all accounts affected by the First Time
Homebuyer Credit programming errors, and will adjust them to reflect their
correct status.

We will monitor this corrective action as
part of our internal management control system.

Recommendations

The Commissioner, Wage and Investment
Division, should:

RECOMMENDATION 7

Establish procedures to ensure that the
VIN provided for each vehicle claimed on Form 8936 is 17 characters long and,
using the characteristics of the VIN, ensure that the vehicle is eligible
before allowing the Plug-in Motor Vehicle Credit.

CORRECTIVE ACTION

We are evaluating changes to Form 8936, Qualified
Plug-in Electric Drive Motor Vehicle Credit, which will ensure reported
Vehicle Identification Numbers (VIN) contain the requisite number of
characters. ******2********
*********************************************2********************************************************************************************2********************************************************************************************2********************************************************************************************2*********************************************************************************************2*********************************************************2***************.

We will monitor this corrective action as
part of our internal management control system.

RECOMMENDATION 8

Initiate a program to recover the
erroneous Plug-in Motor Vehicle Credits the IRS allowed on the 574 tax returns
we identified.

CORRECTIVE ACTION

We have developed a business rule to
identify returns claiming the Plug-in Motor Vehicle Credits for additional
review. The Compliance functions will select a sample set of returns for
inclusion in the Fiscal Year 2014 Exam Plan. The results of the sample
examinations will be evaluated and considered in determining if expansion of
the sample is an appropriate use of limited resources, or if the issue
displaces other work that is more productive.

[10]
Other Contacts includes Form 2063, U.S. Departing Alien Income Tax Statement,
date-stamping tax returns brought in by taxpayers, screening taxpayers for
eligibility of service, scheduling appointments, and helping taxpayers with
general information such as addresses and directions to other IRS offices or
other Federal Government agencies.

[11]
In Fiscal Years 2012 and 2013, Tax Returns Prepared is included in Other
Contacts.

[12]
The IRS refers to the suite of 27 telephone lines to which taxpayers can make
calls as “Customer Account Services Toll-Free.”

[13]
The IRS’s Customer Service Representative Level of Service measure only
reflects the relative success rate of taxpayers who call the IRS’s 27 toll‑free
telephone lines seeking assistance from an assistor.

[14]
The Tax Returns and Sites totals do not include tax returns prepared using
Facilitated Self-Assistance or those sites.

[15]
Treasury Inspector General for Tax Administration, Ref. No. 2012-40-119, The
Majority of Individual Tax Returns Were Processed Timely, but Not All Tax
Credits Were Processed Correctly During the 2012 Filing Season (Sept.
2012).

[19]
Treasury Inspector General for Tax Administration, Ref. No. 2012-40-119, The
Majority of Individual Tax Returns Were Processed Timely, but Not All Tax
Credits Were Processed Correctly During the 2012 Filing Season (Sept. 2012).

[20]
A judgmental sample is a nonstatistical sample, the results of which cannot be
used to project to the population.

[21]
A home is considered disposed if the taxpayer sold the home or the home was
foreclosed upon, converted for rental or business use, or destroyed or condemned.
A home is also considered to be disposed when ownership of the home is
transferred as part of a divorce settlement.

[22]
Treasury Inspector General for Tax Administration, Ref. No. 2011-41-011, Individuals
Received Millions of Dollars in Erroneous Plug-in Electric and Alternative
Motor Vehicle Credits (Jan. 2011) and Ref. No. 2011-41-128, The Passage
of Late Legislation and Incorrect Computer Programming Delayed Refunds for Some
Taxpayers During the 2011 Filing Season (Sept. 2011).

[23]
A judgmental sample is a nonstatistical sample, the results of which cannot be
used to project to the population.